Grandstanding Problem

Grandstanding Problem

To understand the significance of the grandstanding problem (Gompers, 1996), one must remember a fundamental characteristic of the world of private equity and venture capital that is related to the relationship between returns and deals conducted.

By now it is a well-known fact that the overall return for venture capitalists depends on a small number of deals or rather a small number of financed companies. Successful investments, in other words those that guarantee the highest performance, can be attributed to ventures that culminate in an IPO (i.e., with the listing of the financed company).

Consequently, the IPO is the best method available to venture capitalists to build their reputation and become successful players, or at least players capable of building the business of the companies they finance.

The grandstanding problem is a flaw in this mechanism and is actually caused by opportunistic behavior by venture capitalists. Specifically, they could opt to list a company prematurely, simply to build their own reputation on the market.

Following this rationale, people with little experience are especially keen to list companies on the market for their own ulterior motives (reputation build up) rather than to generate value for all the shareholders.

The consequences of listing an immature company are essentially two: major underpricing on the first day of listing, due to greater information challenges and investors’ fear for adverse selection problems, and a substantial slowdown in corporate development, because after the IPO the venture capitalist would no longer be there to provide company advice and nonfinancial resources.